It's Not Just the Economy Stupid!

“Greeks are protesting new austerity measures” is a common headline these days. It definitely captures some of what protesting Greeks are doing, but certainly leaves a whole lot out of the picture. Many Greeks are protesting not only the deterioration of their standard of living, but equally importantly, what they experience as a political disenfranchisement that has been orchestrated by the government, with the collaboration of the European heads of state. The situation in Greece is going to get much worse not only because of the economy, but also because of the repressive politics that are threatening to ignite Greek society.

To understand the Greek political cauldron you need to put yourself in the shoes of the average salaried Greek and what she has experienced these past two years. Picture this:

Greek Family and Welfare Provision

I have argued previously (here) that the EU/IMF/ECB insistence on “flexibilizing” labor law in Greece overlooked the basic structure of the Greek private market, which consists overwhelmingly of small, family owned and operated businesses, with ultra –flexible wage arrangements (a wife’s labor, especially, is often unremunerated). Add de facto non-enforcement of labor law even in the tiny segment it applied to and the massive informal sector and you end up with one of the most flexible markets, labor cost-wise, in Europe. Moreover, despite the infamous Greek welfare “drones” in the media, Greece does not have a welfare regime comparable to the rest of Europe. In fact, much like in the US, the Greek family internalizes most of the cost of basic services such as education, healthcare, housing. State employment and pensions have for a long time played the role of a substitute for the lack of such a welfare regime, for those of course who could access these jobs, usually on the basis of clientelist relations. The basic structure of state employment included jobs distributed widely among the client base of the governing party, with wages too low as remuneration and too high as welfare, along with privileged wages and perks for a narrow elite group within the public sector. Average wage and pension levels remained well below European levels before the crisis, while consumer prices had skyrocketed and remain among the highest in Europe even today.

All this may help clarify the compounded impact of the austerity measures on the average Greek. Dramatic wage cuts in both the public and the private sector, along with a largely successful program of taxation mainly targeting the salaried and small businesses transformed private sector workers and the average public sector worker into a newly struggling lower middle class or the newly poor-depending where they started from. The tax campaign also led to the closure of tens of thousands of businesses, while consumer prices remained steadily high. During all this, the family has been providing basic welfare except with less capacity to absorb the cost as unemployment skyrockets and the wages of those who have jobs are slashed. According to a friend, the new trend in one small city in northern Greece is for families to take in elderly relations, aunts, uncles, in return for their pension. People in their mid thirties, who had barely made it out of the parental household before the crisis are now moving back in. In Athens, which has been hit the worst, new forms of solidarity are being invented everyday (such as the “social kitchen” advertised here), but redistribution within the family still remains the main shock absorber. Overall capacity for shock absorption, however, may be busting at the seams as can be seen from Sunday’s events.

The Value(s) of Foreclosure Law Reform?

As Alan White reported recently, the Uniform Law Commission in the U.S. has named a committee to consider the need for and feasibility of proposing a uniform foreclosure act and to report back to the ULC by early 2012. A letter from the ULC president includes a list of questions that the committee is charged to consider. But what principles will guide their analysis of these questions?

Financial Stability Board Calls for Effective Consumer Finance Protection

The Financial Stability Board, an international organization operating under the auspices of the G20 countries, this week issued its Report on Consumer Finance Protection. http://www.financialstabilityboard.org/publications/r_111026a.pdf FSB emphasizes the link between international financial stability and consumer protection, particularly in the mortgage markets. It calls for regulation to assure assessment of borrowers’ ability to pay and to police credit product features that increase risk. The report engages in some comparative analysis and identifies national regulatory architecture that has been particularly effective, such as that of Australia. The report is part of an initiative to stimulate more international discussion of effective means of consumer protection, particularly concerning credit. FSB increasingly sees consumer protection as part of its mission to assess and address vulnerabilities in the international financial system. The report is worthy and sensible. Of course, implementation, primarily by domestic regulation of financial institutions, is a huge challenge.

First to File--Patent Thoughts

Congress just passed a bill overhauling the US patent system.  The most significant change appears to be shift from a first-to-invent to a first-to-file system.  Now, I am not a patent scholar and am wading into unfamiliar waters by opinining in any way on this shift, but it's rather fascinating to consider from a comparative perspective with security interests in personalty and realty, where first-to-file is generally the rule (with important exceptions like relation back for purchase money security interests and priority by possession or control).  

So, as I understand it, a key problem with first-to-invent was that it was rather time-consuming to determine who actually invented something first. Administratively, that seems like a cumbersome system, even if it does help protect original thinking. 

At first glance, first-to-file seems like a much easier system administratively, which will speed up the patent process and create more certainty in property rights--and certainty is the major goal of any property title system. It should eliminate litigation over priority of invention.  (Put differently, we're going to a pure race system, not even race-notice.) But I suspect that first-to-file will just put more weight on the question of whether A's filing covers the same property as B's filing. If A and B have filed for patents on separate ideas, then there's no competition in rights and no problem. The danger, it would seem, is that first-to-file might encourage prophylactic filings. I'm not sure how easy that is to do, but encouraging a race could undercut the efficiency gains by not having to adjudicate who was first to invent.  

Saab in New York?

So the Swedish court's decision to deny Saab's reorganization petition gets me wondering if the company might not decide to file a US chapter 11 case. The only problem is that, best I can tell, Sweden has no provision for recognizing a foreign insolvency proceeding domestically. Thus, like most of these foreign chapter 11 cases, the proceedings would only bind international creditors (i.e., financial institutions) and that may not be enough to solve Saab's problems.

They should have never given up on those hatchbacks.

Foreclosure Crisis in Europe vs US

While European markets have seen increases in mortgage foreclosures, more robust regulatory intervention seems to have kept defaults and foreclosures to much lower levels than we are experiencing in the United States.  At the peak of the crisis a year ago, about 9% of US mortgages were in serious default (90 days or more past due or in foreclosure.)  The United Kingdom and Spain had default rates of less than 3%, which they still regard as a crisis.  The only EU country with mortgage defaults exceeding US levels is Latvia.  Detailed information on European foreclosure rates and prevention measures are available at the EU web site on the new mortgage credit legislation.  The report containing the table on the right is available here.

 European banks argue that the lower default rates are a result of less reckless lending prior to the crisis, compared to the US subprime market, and that may be true.  It is also clear from the EU Commission summaries that most European countries have actively required or strongly encouraged lenders to work out as many troubled mortgage loans as possible, and have introduced delays and procedural hurdles in the foreclosure process to further stimulate workouts. 

The UK launched two subsidy programs at about the same time that the US Administration launched HAMP in 2009.  The Homeowner Mortgage Support allowed borrowers with a temporary income loss to defer payments for up to two years, with the government providing the lender a guarantee in the event the borrower defaults in repaying the deferred interest.  It expired in April 2011.  The Mortgage Rescue Scheme provided government support for shared equity and right to rent programs, and the Support for Mortgage Interest program subsidizes interest payments for homeowners receiving income support benefits.

In 2009 there were about one million completed foreclosure sales in the US (out of about 60 million mortgages outstanding.)  In the UK there were 54,000 (out of about 15 million mortgages.)

Culture, Attitudes, and Debt

Rather than a post with a lot of (supposed) answers, today I have a post with a lot of questions. My goal is to start a discussion that I hope our insightful readership will take up in the comments.

Lately, I have been thinking a lot about cultural attitudes toward debt. I am not really sure what I mean by "cultural attitudes." The idea is that Bob Lawless, sitting here in Champaign, Illinois, has certain beliefs toward debt--when it is appropriate to use debt, when borrowing is irresponsible, and so forth. These beliefs about debt might differ from someone who had different life experiences because of different socioeconomic circumstances, because of experiences in another country, or because of other differences that broadly travel under the rubric of "culture." There is empirical evidence that, with "culture" defined in this broad way, differences in cultural attitudes toward debt exist.

Responsible Lending as an Emerging International Norm

The International Association of Consumer Law, with participants present from six continents, has been meeting at Brunel University in West London the last few days, hearing presentations from regulators, industry representatives, consumer advocates, and academics.   http://qwww.brunel.ac.uk/bls/research/events/ne_41734   Not surprisingly, regulation of consumer credit has been a prime focus, giving some perspective on US struggles to achieve more effective consumer financial protection. 

Professor Iain Ramsay of the University of Kent in the UK reported on initiatives for international cooperation to enhance consumer financial protection.   The G20, World Bank, Financial Stability Board, and Organization for Economic Co-operation and Development are all on board with this goal, seeing it as an essential part of a program to ensure that the international financial system is safe and sound.  The OECD is expected to issue draft principles of consumer financial protection soon, and comments will be invited.  Given the primarily prudential role of these organizations, balance from other sectors will be important.

Ramsay raised an underlying and overlooked question:   what is the economic and social value of consumer credit?

India’s Microfinance Industry Fuels Suicides

Most of us remember Muhammad Yunus’s 2006 Nobel peace prize for microfinance, small loans to start businesses, with extremely low default rates. Now it looks like this industry has done what many American financiers have done, lent more than people can ever pay back, in order to make greater profits. In India and other parts of Asia, however, cultural factors mean that over indebtedness causes more than just sadness and bankruptcy. This lending without regard to ability to repay has causes suicide on the part of borrowers. This is particularly insidious, given that- unlike home loans or payday loans in the U.S. -  the whole point of microfinance is to help the poor start businesses.

Market Governance Is About People (And How They Think)

Hello everyone and thank you so much to Bob and Adam for bringing me into this exciting conversation. This week I want to raise with you a few thoughts about the way forward on financial regulation that have come out of interviewing and observing regulators in their interactions with market participants over ten years. My research has been mainly in Japan but involves some US components as well.

Welcome to New York; the Bankruptcy Court is Below the Museum

While most of the recent focus in the reorganization area has been on a handful of “mega” cases that played key and controversial roles in the financial crisis, the bankruptcy court in Manhattan has quietly become the international center for corporate reorganization. And I’m not just talking about chapter 15 cases, like those recently filed by Mexicana Airlines, and a boatload of English reinsurance companies, that simply ask the US court to help enforce a foreign bankruptcy proceeding.

The Mother of All Cross-Border Bankruptcies?

No, not Lehman.  Though  much smaller in monetary terms (probably), a filing by BP would likely be the biggest international insolvency case in engaging the U.S. public interest, and probably its ire.  And what of a BP filing in its jurisdiction of registry?  A BP filing in the U.K. seems sure to create a cross-the-Pond furor not seen since the late 1700s, or so this BusinessWeek article suggests.  One line from that article particularly intrigued me:  "No doubt London courts would deliver an outcome more favorable to BP. And they’re apt to be less generous when it comes to paying damages to folks three times removed from directly affected claimants."  No doubt, eh???  This is, of course, the primary concern in cross-border cases, generally, but I think this worry is overblown (sensationalist journalism from BW--go figure!).

First, British reorg/rescue law still remains less debtor-friendly (and decidedly less management-friendly) than the U.S. Chapter 11 system (see, e.g., this very useful comparison), and management decides where to file.  While a U.S. DIP might well be able to maneuver the proceedings to low-ball Gulf-area claimants, I doubt a U.K. administrator would be willing to face the international backlash of such a tactic, especially since the adminsitrator would not be biased by his or her own participation in the creation of the catastrophe (unlike the DIP) and would have no reputational "sunk costs" to attempt to salvage (again, unlike a DIP).

Second, to the (unlikely) extent that the Businessweek article is making the sophisticated suggestion that British law would be chosen to control matters of claims administration and distribution, this is probably just wrong.  Cross-border insolvency law doesn't deal with such matters, and Jay Westbrook has written some very thoughtful analyses of the sticky choice-of-law issues in this context (I couldn't find any public hyperlinks, but see especially 23 Penn State Int'l L. Rev. 625 (2005); 33 Texas Int'l L.J. 27 (1998); and 65 American Bankruptcy L.J. 457 (1991)).  Any reasonable choice of law analysis would lead to application of U.S. law to the Gulf disaster, and a U.K. judge would be very hard-pressed to "deliver an outcome more favorable to BP" if that meant doing anything that remotely resembled flouting the governing law.

Might BP avoid punitive damages and other uniquely U.S. craziness by filing in the U.K.?  Probably, but my sense is BP would not face such emotion-driven madness in U.S. Bankruptcy Court, either.  State court tort trials get big headlines, but the bankruptcy cases that bring those damage awards back down to earth seldom catch the public's attention.  A long line of cases beginning with Maxwell suggests that U.K. and U.S. bankruptcy judges are more or less of one mind, so the only remaining questions concern choice of adminitration and choice of law.  The former strongly favors a U.S. filing (if any), and the latter should be indifferent to the choice of forum (no, I'm not being Pollyanna-ish here, I really do believe the choice of law would work out the same on either side of the Pond).  So, John Conyers, put down that silly bill to prohibit U.S. cooperation with a U.K. filing by BP, and focus on helping to clean up the mess down in the Gulf! 

What's Wrong with PIGS?

The financial and economic woes of the Southern European bloc of Greece, Italy, Portugal, and Spain have been constantly in the headlines recently (just this morning, the ABI's quite useful Global Insolvency daily headlines included just such a story).  Indeed, I learned that the cognoscenti call this group by an acronym:  PIGS (PIIGS if you add also struggling Ireland).  What do these countries have in common that might bear some causal relationship (forward or backward) with their money trouble?  I now have proof positive that I am a certifed weirdo, because the first thing that popped into my head when I saw these countries grouped together was that they are unique in Europe in not having a consumer insolvency system (or at least any reasonably functioning system).  For a long time, these countries had no robust consumer borrowing that might lead to consumer insolvency, but lots of data (no hyperlinks come readily to mind) indicate that those days are over, and it's high time for PIGS to respond to a growing incidence of consumer financial distress. The NYT story linked above suggests that geography, culture, religion, and history might tie these countries together and distinguish them from the rest of Europe.  Now I'm really intrigued by the causation-correlation issue here:  I suspect the lack of an effective consumer bankruptcy system is a result of unique cultural, religious, etc., characteristics of PIGS (and PIIGS), but I can't help wondering if there might be a causal effect the other direction, or at least that the conspicious absence of a serious effort to deal with consumer financial distress is a canary in the coal mine revealing the pernicious effects of certain other, otherwise unobjectionable cultural tendencies.  Hmmmmmm . . .

New Reorganization Law Imminent in United Arab Emirates

The key word in the title to this post is "reorganization," as opposed to what one generally finds in the context of laws on business failure--liquidation or "bankruptcy" laws.  The U.A.E.'s current bankruptcy law is a relic of the (British influenced) past, clearly designed more to punish debtors than to protect creditors (yes, I do mean to suggest that these goals have virtually no cause-and-effect relationship, despite constant unsupported rhetoric to the contrary among some commentators).  For several months now, U.A.E. authorities have been promising a new reorganization law to deal with recent spectactular financial collapses in what may well be the Arab world's most advanced and diversified economy.  Along with an advanced economy, they have implicity acknowledged, goes advanced failure, and a safety valve for treating that failure is a must for disciplining creditors and investors at both the investment and the recovery stages.  Even the insolvency law in the Dubai International Financial Center is not particularly forward-thinking, so even though reports are that the new U.A.E. law will not be as reorg-friendly as U.S. law, I hope the drafters drew their inspiration from sources other than British law (no "anti-British" sentiment is intended here).

Islamic Finance v. Islamic Bankruptcy

As Bob mentioned in his introduction, I have spent many hours over the past year-and-a-half studying Arabic as a prelude to exploring the Islamic and Modern Middle Eastern law of financial distress--by far the most intense intellectual challenge of my life.  I've only begun to scratch the surface (the language alone is fiendishly difficult), but this promises to be a very interesting and productive project.

While most Credit Slips readers have heard of or, indeed, know some of the detail of the modern movement known as Islamic finance, I suspect virtually none of us knows anything about the way in which Islamic law deals with financial distress and bankruptcy.  The only non-Arabic source on this subject I have found is an early 1900s doctoral disssertation from the University of Paris, and it is largely a French summary of the bankruptcy law of Morocco at the time (heavily influence by Hanafi Islamic doctrine).  We've probably also all read the stories of ex-pats leaving their cars at the Dubai airport, fleeing to avoid imprisonment for debt, but even in places like Saudi Arabia, where shari'a is supposed to be the law of the land (and where a kind of nascent debt settlement system is developing, albeit slowly), I haven't see any evidence of serious engagement with the notion of bankruptcy as it appears in the primary Islamic law sources.

And appear it does!  One rather famous verse of the Qur'an, 2:280, directs (liberally translated) "If [he, the debtor] is in a difficult situation, let there be a postponement until easier times [and he is able to repay,] and if you were to remit [forgive] the debt [as charity,] it would be better for you, if you only knew."  And in the other major source of Islamic law, the sunna (tradition) of the Prophet (pbuh), one finds at least one story where a creditor is ordered to forgive half of his claim against a distressed debtor.  There are other similar stories in the sunna, and I very much look forward to sifting through the scholarly commentary on this issue, a process that I've begun with halting success.  If any Credit Slips readers are familiar with what Hanifa or Shafi'i or Hanbal or Malik or Ja'far or any other authoritative commentator has to say about this specific issue, any input would be welcome.  My greatest point of curiosity is why we don't see any serious treatment of bankruptcy in modern Middle Eastern law, despite its treatment in Islamic doctrine.  This is one of many interesting facets of my longer-term project.  As I've said before, we in "the West" have so much to learn, both about and from, "the Rest" of the world.

The Forum Shopping Debate Heats Up for In-Bound Cross-Border Cases?

Thanks so much to Bob and the rest of the Credit Slips crew for having me back!  For my first post, I thought I'd draw some attention to what seems to be the latest in the forum shopping (corruption?) wars in the U.S. Bankruptcy Courts (which also ties in my new Arabic study a bit).  Many people, including myself, have written on the seemingly foreign-insolvency unfriendly decisions out of the Southern District of New York involving the Bear Stearns and Basis Yield collapsed hedge funds.  Relatively few people seem to have picked up the latest, a decision from traditionally more friendly Delaware in a case involving a Saudi-owned, Cayman-registered hedge fund called Saad Investments Finance Co. (No. 5) Ltd. (Case No. 09-13985) ("SIFCO").  Ironically, SIFCO's name (sa'd) means, in Arabic, “good luck” or “good fortune.”  As it turns out, the liquidators’ choice of the District of Delaware to seek cooperation in this cross-boder bankruptcy case was, indeed, fortunate.  Not only did the Delaware court not go out of its way sua sponte to find reasons to reject SIFCO's liquidators' petition for recognition (as the New York court had done), it seems to have almost glibly concluded that SIFCO's "center of main interests" was in the Cayman Islands, despite circumstantial evidence to the contrary (as discussed in the Bear Stearns and Basis Yield cases) and without citing either the controlling law or any particular fact that supported this crucial finding (see p. 2, finding "I").  This decision, in stark contrast to the New York holdings, seems rather transparently based on public policy and comity, rather than (and perhaps in derogation of) the new governing statute, Chapter 15 of the U.S. Bankruptcy Code.  While a few commentators have tried to rationalize this case by contrasting SIFCO with the Bears Stearns and Basis Yield hedge funds, the only explanation that seems at all persuasive to me is that the Delaware court has once again positioned itself as the "debtor-friendly" (or now, foreign-representative-of-the-debtor friendly) forum for U.S. bankruptcy proceedings.  I'll leave it to those who are both more expert (see also here and here) and much braver than I to conclude whether this is in fact the meaning of the latest Delaware decision and, if so, whether that represents a good or not-so-good development for U.S. cross-border bankruptcy policy.  I'll have more to say about this decision in the next issue of the Cayman Financial Review, for which I have been invited to write a bankruptcy column this year (thanks so much to Andy Morriss for the invitation).  Thanks once again to Credit Slips for having me back!

Debt and the People, Part II: The Hot ... and Concluding Disquietudes

This last post is about old news that I have been avoiding.  Even so, it would be malpractice to omit Ecuador from even this partial snapshot of the sovereign debt landscape circa 2010.  So on with its latest debt default, and all that it has dredged up. 

In a nutshell, Ecuador announced in late 2008 that it would stop servicing two of its foreign bonds; six moths later, it bought most of them back for cash at about 35 cents on the dollar, effecting substantial debt relief.  Three things about the episode bear emphasis.  First, Ecuador specifically refused to claim that its debt was unsustainable by IMF metrics conventionally used as a threshold for sovereign debt relief in the absence of a formal bankruptcy regime.  Second, on the eve of the default, a Presidentially-appointed audit commission deemed the debts irregular and illegitimate.  However, not all the debts condemned by the commission were then formally renounced by the government.  Third, instead of walking away from the debt, Ecuador ended up reverting to market mechanisms to buy it back at a discount.

De-Detour: CDS Nudity on the Exotic Fringe

A recent FT Editorial implicates a topic I -- basis risk in emerging markets (EM) credit derivatives.  The problem is this:  If you want to buy protection against default by a big U.S. firm--say, GM--you buy a CDS contract on a GM bond.  But even in the leading emerging markets, it is often difficult to buy protection on major corporate credits, especially if you want to hedge against default on local-currency or other non-dollar/euro/yen obligations.  This is because local financial markets are relatively thin.  Your choice then is to buy a liquid standardized instrument, such as a CDS on foreign-currency sovereign debt, or to negotiate an expensive bespoke contract with a party willing to take the precise local risk off your hands.  If you opt for the liquid standardized sovereign CDS, you get partial protection.  This means that if your borrower defaults but the government is still servicing its dollar-denominated foreign bond, you cannot collect.  Herein the basis risk.  Note that even if you were able to arrange bespoke protection, you could be taking on more counterparty risk, since the only people willing to insure illiquid local instruments might be local institutions more exposed to measures such as capital controls ... or risk-hungry fringe elements that might flake out on you.

How is any of this relevant to the current debate on regulating "naked" CDS, or credit protection not matched by exposure to the underlying credit (aka fire insurance on your neighbor's house)?  It goes to the difficulty of defining the subject.  A CDS that might appear naked at first blush could in fact be partially clothed; and instead of encouraging better hedging, we might end up eliminating what partial protection is available in less liquid markets (damage insurance on your block?).  Not to say that EM basis risk should even remotely drive the discussion, but the example does expose the challenge of figuring out not just the legal terms of the regulated instruments, but the often less-than-intuitive ways in which they are used.

Debt and the People, Part I: The Cold

In earlier posts, I considered two trends:  first, the eroding boundary between chronically defaulting sovereign and risk-free government debt; and second, the comfy symbiosis among feckless rules, fudged government accounts and basic financial engineering.  I also considered the politics of erosion and symbiosis.  In this post and the next, I move to a third trend, perhaps the most overtly political of the lot: the resurgence of popular input in national debt matters.  The latest exhibit in this trend is Iceland, whose money troubles gave Michael Lewis the opening to set Beverly Hillbillies in Lake Wobegon.  The immediate predicate for this post is last weekend's referendum, where over 93% of the voters rejected a plan for Iceland’s government to guarantee payments to the United Kingdom and the Netherlands, compensating them for compensating their nationals who lost money in Icelandic internet bank accounts.  Curious referendum factoids include that (a) the deal voted on had long been superseded, and (b) “yes” votes came in third after empty ballots.  But the back-story is serious, complicated and revealing.

Do Not Miss

William White has a rocking op-ed in the FT arguing that debt overhang, notably in the U.S. household sector, makes fiscal and monetary policy ineffective.  White is one of the early pre-pre-pre-crisis proponents of macroprudential regulation, and always worth tuning in for.  Amen and testify.  (I am biased, as have been sympathetic to across-the board debt reduction in crisis.)

Gary Gensler uses the Greek controversy (and AIG) to argue the CFTC regulation brief, notably clearing houses.  He is a smart and complicated guy, and his argument is more nuanced than the demonization din.  He says that Greece might not have done the "Euroliar loan" swaps had the proposed reforms been in effect, because it would have had to post collateral, which would have made the transactions either useless or prohibitively expensive.  I leave the unpacking to the experts, but I suspect that it depends on some key factors in both the law and the swaps.  Nevertheless, a more productive framing for the conversation.

It's All Greek to Me FAQ, Part II: Euroliar Loans

While they hold some allure for the pointy-headed company I normally keep, the old fixing-floating-IMF-bailout handwringing detailed in my last post is nothing to the titillation of the Goldman-CDS angle on the Greek drama.  FAQ series continues with a focus on lying.

Who lied, to whom, about what?

It's All Greek to Me FAQ, Part I: Power of Commitment

This follows on Stephen's post earlier in an effort to help sort through the Greece-Goldman-Germany love triangle and the deafening din surrounding its implosion.  This post sets out the background for the Greek crisis, mulls law as a macro commitment device, and the relative merits of EU and IMF bailouts.  The next one goes into more depth on Goldman and derivatives.

Why is everyone talking about Greece?

It’s the Olympics! (Did You See the Inflatable Beavers?)  And because Greece needs to come up with Euro 20 billion (about $27 billion) by April-May to roll over maturing debt.  Greece is having trouble borrowing the money because its debt stock is pushing levels that help poor developing countries qualify for official debt relief, with little prospect of going down.  As a result, Greece may have to pay a 4% premium over Germany, if it can borrow at all.

So what?  What happens if Greece defaults?

What? Sovereign Debt Edition

I'm sure our current guest blogger will have more to say about the current state of the sovereign debt markets, but I could not resist commenting on this rather confusing and odd article in today's FT about Goldman and Greece. Turns out part of the problem is that the article uncritically rehashes this letter from Representative Maloney, which is itself confusing and odd.

The key quote from both is this: "The increase in demand for insurance on government debt through credit default swaps harkens back to the activities that brought down American International Group." I'm not sure quite what this means, but the apparent analogy is flawed for several reasons. First, AIG was selling CDS with no real risk management, whereas Goldman is now buying CDS. Greece is neither buying nor selling CDS, although the article and letter might leave you with that impression. Second, while I've certainly argued that corporate CDS can generate perverse incentives to push a company into bankruptcy, I've also warned against the unthinking importation of corporate bankruptcy concepts into the sovereign debt world, and this analogy seems to be headed in that direction. Sovereigns -- at least at the national and state level -- can't be pushed into bankruptcy involuntarily, indeed they can't file for bankruptcy at all. That's an important difference that is often lost in the breathless commentary that the CDS markets will lead to a Greek/Icelandic/Portuguese/Californian "bankruptcy." Finally, I'm not sure why the "increase in demand" for sovereign CDS is itself anything to be concerned about -- other than what it suggests about the underlying problems with sovereign borrowers.

Indeed, I don't really understand the basis for the argument, made in the New York Times this week, that sovereign CDS will somehow push Greece to default, although I note that the AIG quote from FT and the Congresswoman could be charitably described as a restatement of the second paragraph of the NYT article. The Times article itself suffers from the sovereign/corporate confusion I discuss above.

At heart, the FT article (along with the Congresswoman's letter) seems like a rather feeble effort to link the present problems regarding Greece to the new easy target for all financial reformers:  CDS.

Why Sovereign Is the New Black

I am grateful to Adam and the Credit Slips team for indulging this detour.  After years on the exotic fringe of the legal academy sustained by the entrepreneurial spirit of Mitu Gulati, sovereign debt has blown right past the sleepy mainstream into the screaming headines.  Before launching into the substance of today’s crises and controversies, it is worth pausing to ask why.

First, the new celebrity sovereign debt is qualitatively different from the old fringy sort.  Old sovereign debt was about poor and middle income countries.  It surged with petrodollar lending in the 1970s, imploded in 1982, and re-surged in the mid-1990s, when it became Emerging Markets (EM) sovereign debt.  Much theory and jurisprudence ensued, which keyed off the problem of sovereign default:  the debt was apparently unenforceable despite restrictive immunity, yet this did not seem to dissuade lenders from lending and borrowers from paying most of the time.  Law scholars used sovereign debt as a natural experiment in theories about corporate contracts and bankruptcy.  The theory and practice of this “sovereign debt” were worlds apart from “government debt.” The former had an aggregate outstanding stock of a few hundred billion dollars spread among a few dozen countries (J.P. Morgan's EMBI, give or take) and was all about currency mismatch, default and recovery values.  The latter was in the way trillions, risk-free and “information-insensitive.”  You could buy default protection on the former; it made no sense to write protection on the latter.

The latest crisis in the Euro area has helped collapse the distinction between little “them” and big “us”; now everyone is groping along a discomfiting continuum muttering about market confidence.  Emerging Markets analysts are manning mainstream desks, I read about Greece in EM dailies, erstwhile über-skeptic and real-law person Kim Krawiec blogs about it at Faculty Lounge, and the whole thing feels totally self-justified without being useful to corporate theory.

Welcome Back Anna Gelpern

The Slips is pleased to welcome back Professor Anna Gelpern of American University's Washington College of Law for another guest bloggership.  Anna's written extensively on sovereign debt crises (see here, here, here, here, here, here, and here, among other papers), and we are thrilled to provide a platform for her to share her thoughts on Greece, Dubai, Ecuador, and any other sovereign (including California and Illinois).  (She's also written a great paper on mortgage-backed securities workouts, which have some of the same collective action problems as sovereign debt workouts....) 

The usual repast at the Slips is consumer and business credit in the United States, but we're always interested in credit more broadly, including comparative credit systems and sovereign debt.  Unfortunately, given US government budget deficits, we may all want to become a little better versed in sovereign debt issues. 

A very brief primer for our readers who are not familiar with sovereign debt issues.  Sovereign debt presents four critical differences from consumer or corporate debt.  First, it is very hard to collect if the sovereign doesn't pay; Argentina's creditors have been trying for years to lay their hands on Argentine state assets, but there are few outside of the Argentina.  Second, there is no bankruptcy option for a sovereign; there is no legal mechanism for discharging debt at less than 100 cents on the dollar.  Third, sovereign debt is intimately tied up in both domestic politics and the politics of international relations.   And fourth, sovereign debt is highly intertwined with currency markets.  These four factors are central in shaping sovereign debt crises.  Again, welcome back Professor Anna Gelpern. 

Monetary Policy and the Housing Bubble

A popular explanation of the financial crisis lays the blame at the feet of the Federal Reserve for lax monetary policy.  In this story, the Fed dropped interest rates starting in 2001 and kept rates too low for too long.  Low rates induced an orgy of mortgage borrowing for leveraged home speculation. 

It's a nice story.  Only problem is it doesn't really hold up under inspection.  Low rates in 2001-2003 did fuel an amazing mortgage refinancing boom, but not a purchase boom, and the boom was mainly in conventional fixed-rate mortgages, not the exotic products later years.  Moreover, despite the refinancing boom, no housing bubble was emerging in this period. 

The Fed started to raise rates in mid 2004 and continued to do so until mid-2006.  It was during this period that the bubble emerged, when rates were going up.  (To be fair, some might argue for an earlier date to the bubble, even as far back as the late 1990s.)  If we date the bubble from 2004, it's not consistent with a rate-driven bubble story, although rates were still extremely low in absolute terms during this period. 

The monetary policy story, however, really falls apart when one compares the US and Canada, as the graph below does.  Canadian interest rates, and perhaps more importantly, Canadian mortgage rates, track US rates pretty closely.  Yet the US had a housing bubble, and Canada did not.   This means we have to look somewhere other than monetary policy to explain the housing bubble.  The answer, I believe, lies in method and regulation of housing finance. 

Lehman, Synthetic CDOs, Sapphires, etc.

The Lehman bankruptcy court is out with a new decision that has the financial community somewhat miffed, since it removes one more piece of their mistaken belief that they don't have to understand or deal with the Bankruptcy Code. The decision will also lead to some interesting discussions with members of the English bench, who reached a contrary decision with regard to the same issue and parties. I'm extending an open invitation to all the judges to join me for coffee and bagels at my apartment on the UES to sort things out.

I've represented the transaction in question, which involved the issuance of synthetic CDOs, in this simplified diagram. The key thing to understand is that under the terms of the deal, which contains an English choice of law clause, the priority rights to the collateral switch if there is a Lehman default under the CDS contract. And Lehman Brothers Holding's chapter 11 filing in September 2008 constituted a default, since Holdings was a "credit support provider" under the terms of the CDS contract. The CDS buyer, LBSF, also filed a chapter 11 case of its own in October 2008, resulting in another default.

The other thing to understand is that there are reportedly about 1,000 similar Lehman transactions waiting in the wings.

The US bankruptcy court held that the collateral priority switch was an unenforceable ipso facto (bankruptcy termination) clause, and that the derivative "safe harbor" provisions in the Code did not apply.

The UK Court of Appeal, affirming a decision of the High Court of Justice, reached the exact opposite conclusion, holding that the deal did not violate the "anti-deprivation rule," which is essentially their rule against ipso facto clauses, based on a case from 1818.

(How we ended up with the pseudo Latin, when their rule is from 1818 and ours is from 1978, I don't know.)

My thoughts on the bankruptcy court decision, and the conflict with the prior decision from the UK, after the jump.

Keeping it In-House

Rather than risk a Dubai World chapter 11 case, Dubai is apparently doing a quickie revamp of its bankruptcy code. Of course, the code itself is only half, or less, of the issue -- you also need the structures to properly implement the code (see China, People's Republic of). I suspect many international creditors would still prefer a New York or Delaware bankruptcy court, but it may not be their choice to make.

Dubai World

Over the long holiday weekend, we have been treated to a series of increasingly breathless stories about Dubai World's decision to seek a six-month moratorium on some $60 to 80 billion of debt. How Dubai World, a corporation owed by the government of Dubai, will resolve its debt issues has been the subject of much speculation, and little hard fact. Indeed, I believe I saw one story that said Dubai was going to trade Clay Buchholz for Roy Halladay at the Winter Meetings -- but maybe I'm getting my rumor-filled stories mixed up.

One option that has yet to be mentioned is a Dubai World chapter 11 filing. Foreign companies file chapter 11 all the time. Sure the automatic stay is unlikely to have much effect on local creditors in the UAE, but such a filing would prevent any creditor will "minimum contacts" with the United States from taking any of the debtor's assets. That would cover most financial institutions, including many hedge funds, and might allow Dubai World sufficient time to resolve its problems -- and even impose a compulsory workout plan on the same group of creditors. The key question is whether the government of Dubai wants to expose its key asset to an American bankruptcy process.

The Australian Interchange Experience

The New York Times ran a story on the impact of interchange regulation in Australia.  Calling it interchange regulation is somewhat of a misnomer.  The Reserve Bank of Australia in fact acted to bust up anticompetitive private regulation of interchange.  Payments are an area with intense regulation, but that regulation is often private self-regulation.  Thus, what occurred is better thought of as interchange deregulation. 

Guess what?  Interchange regulation is working exactly as one would have predicted.  Consumers who want rewards have to pay for them directly now.  They can't free-ride off of other consumers (using cash, debit, or non-rewards credit cards) to finance their frequent flier miles, etc.  Not surprisingly, annual fees have gone up for rewards cards.  This has also pushed consumers toward greater debit card usage, which is often a healthy thing.  (To be fair, there is a similar move to debit in the US without interchange deregulation, so the causation in Australia is questionable.)

A predictable problem has arisen in Australia, however.  Some merchants are now imposing credit card surcharges that are greater than the cost of accepting credit card transactions.  This isn't good for consumers.  But it isn't a problem with interchange regulation.  This is just a symptom of less than perfectly competitive markets in other areas of the economy.  Excessive surcharging is most likely to appear in the least competitive areas of the economy. 

Bogus Statistics: The Banking Industry's Go-To Lobbying Tool

Fake statistics have been a central feature of the banking industry's lobbying strategy on every major consumer credit issue since the 2005 bankruptcy amendments. 

In 2005, there was the phantom $400 bankruptcy tax used to push through the BAPCPA.  Then there was the Mortgage Bankers Association's 200 basis point interest rate increase claim about cramdown.  For credit cards, there was no fake statistic, but a pseudo-academic study funded by the American Bankers Association.  (In retrospect, lack of a scare number was a major strategic mistake for the industry.) 

Now we have the latest installment in the parade of phony numbers:  an American Bankers Association-funded study about the likely impact of the Consumer Financial Protection Agency (CFPA) on consumer credit cost and availability and economic growth.  The study is by David Evans of LECG and Joshua Wright of George Mason Law School (Wright may be familiar to some Credit Slips readers from his blog comments in the past). 

There's a lot of tendentious claims in Evans and Wright's study, but the heart of it are some very precise claims as to the impact of the CFPA on the cost of consumer credit (160 basis points), the demand for consumer credit (2.1% decrease), and the net job creation (4.3% slower).

How, you might ask, did anyone possibly arrive at such precise predictions based on legislation that does not create any substantive regulation of the credit industry, but would merely transfer largely existing powers to a new agency? 

The short answer:  just make up the numbers.  I kid you not.  Evans and Wright selectively chose a study on the impact of a different regulation (interstate banking restrictions) on credit cost.  They briefly argue it is analogous to the CFPA Act, which they claim will have double the impact.  (Why double?  Why not?)   Then they take that number and multiply it by an elasticity metric for the demand impact.  And for the coup-de-grace, they take a misleading number on net job creation and conjecture with no basis that it would be reduced by 5%.  These numbers are presented as "plausible, yet conservative" assumptions. 

There's a lot of room for good faith disagreement about methodology, but Evans and Wright's numbers don't come close to passing the straight-faced test.  (Even the Mortgage Bankers Association had some facially plausible basis for their cramdown claim.)  I am still shocked that two serious scholars would attach their names to this study. My short critique of their study is here. 

Lehman Fees

The FT has a front page story today about the total fees incurred by the debtor's professionals in the London part of the Lehman case. So far the accountants (who play the lead role in the UK) and the attorneys are due about $363 million. This got me thinking about a recent WSJ article, which noted that the US part of the case had topped $400 million, further noting that "[f]ee experts have estimated that the bankruptcy could cost between $800 million and $1.4 billion."  The Journal does not say who these unnamed experts are, but I suspect they might be myself and Lynn LoPucki, since the numbers are very close to those we estimated at the outset of the case.

But I estimated total Lehman fees based on its most recent pre-bankruptcy 10-K, and I expect Professor LoPucki did something similar. That means that the London assets were likely included in the estimate (to the extent they were Lehman assets and not trust assets for customers), since the 10-K reports a consolidated balance sheet. That means the "$800 million and $1.4 billion" includes at least part of the UK case, albeit probably with a substantial margin of error, because we are treating the thing as one big chapter 11 case. I know I've never done any testing to see how my model performs on a foreign bankruptcy case.

At this point, the careful reader is probably saying, "wait a second --  once I sum up the total fees in the two jurisdictions, we are already at your estimate.  And the case is not over yet."  True enough, but at least with regard to my fee estimate, this illustrates the simplified nature of the media stories on this issue.

Unresolved Access Issues

Yesterday’s post on means-measuring versus means-testing offered a positive perspective on the Canadian bankruptcy reforms.  The focus was on debtors who are currently able to access the bankruptcy system and how this will change with the enactment of the reforms.  Unlike the American system, the Canadian surplus payment requirements do not impose additional front-end administrative and financial burdens that in themselves will prevent the poorest of potential bankrupts from accessing the bankruptcy system. However, a number of obstacles hinder access to the bankruptcy process for the poorest debtors.  In particular, such debtors will have difficulty paying the approximately $1800 in costs associated with the administration of a bankruptcy.  The reforms go some way to address this concern by providing a mechanism for the bankrupt to reach an agreement with the trustee to continue paying for bankruptcy services after the bankruptcy period. 

Professor Saul Schwartz of Carleton University and I have been working on issues around debt, low-income households and insolvency remedies for some time now.  Jason Kilborn blogged about our 2007 article at: http://www.creditslips.org/creditslips/2007/04/bankruptcy_for_.html.  In that article, we pointed out that, for two reasons, the conventional wisdom is that the poor are not likely to have needed the insolvency system. First, creditors are reluctant to extend credit to the poor because the risks of non-payment are high. Not having been able to borrow, the poor are not over-indebted and are therefore not in need of bankruptcy protection. Second, some poor debtors - lone parents on social assistance for example - are judgment-proof meaning that judgments for money recoveries obtained by their creditors are of no effect because these debtors do not have sufficient non-exempt property or income to satisfy the judgment.

Means-Measuring versus Means-Testing

As readers of the Credit Slips blog are well aware, a central feature of BAPCPA was means-testing.  Means-testing requires all debtors to calculate their estimated ability to pay (according to complex formulae) and to file these calculations with their Chapter 7 petitions.  A failure to do so results in automatic dismissal of their petition.  In contrast, the Canadian approach is to focus on means-measurement.  That is, for liquidation bankruptcies, the bankruptcy trustee on the basis of regulations set by the Office of the Superintendent in Bankruptcy (OSB) sets the amount debtors are required to pay (if any) during the bankruptcy period.  For debtors who are required to pay under the current means-measurement tests, the reforms will increase the period of repayment.  The reforms do not seek to introduce means-testing into the Canadian system.

Functionally, the key difference between means-testing and means-measurement is that means-testing, as put into place in the United States, creates a hurdle at the front end for all debtors filing for liquidation bankruptcies.  The means-testing calculation results in a more complex and time-consuming bankruptcy process, which in turn drives up the fees of filing for bankruptcy, even for those bankrupts who clearly meet the test.  The result is that an increasing number of debtors are not able to afford bankruptcy.  At the ideological level, means-testing operates on a presumption of abuse.

I have asserted that Canada’s resistance to adopting the American means-testing model is a laudable feature of the reforms.  I argue that the Canadian means-measurement approach, while not without its own flaws, is more effective than the American model at putting into practise the objectives articulated by proponents of means-testing in the United States.  See “The Canadian Consumer Bankruptcy Discharge” in Stephanie Ben-Ishai and Tony Duggan, eds. Canadian Bankruptcy and Insolvency Law: Bill C-55, Statute C.47 and Beyond (Toronto: LexisNexis Canada Inc., 2007).

The Deviant Canadian Debtor

The reforms we’ve discussed so far signal that a paradigm shift with respect to consumer bankruptcy in Canada is well under way.  A key component of consumer bankruptcy in Canada has, since 1919, been the non-waivable or mandatory consumer bankruptcy discharge.  In a similar, but more mediated fashion than our American neighbors, bankruptcy’s discharge of past debts that cannot be contracted out of has in recent times been regarded as part of economic rehabilitation, which is equated with a “fresh start.” However, the 1997 amendments attempted to effect a move from rehabilitation of the debtor to asking debtors to rehabilitate their debts by making payments out of surplus income.  The 1997 amendments required trustees to assess whether bankrupts could have made a viable consumer proposal and whether they cooperated with the trustee by meeting any surplus income requirements.

Despite the underlying assumption that many bankrupts have an ability to make repayments to creditors, in practice these amendments had a limited impact on the majority of bankrupts who could not make a proposal because they did not have surplus income.  Over a decade later, the current reforms will take the 1997 amendments further, as these reforms impact bankrupts with surplus income and also expand the group included in the paradigm shift to include certain debtors who do not have surplus income but owe tax debt or student loan debt to the government.  While the 1997 BIA amendments had limited practical impact, they signaled a return to the “deviant debtor” construct, which positions bankruptcy law as a response to deviant behavior.  The current reforms hold the potential to further entrench this construct in Canada’s consumer bankruptcy system.  The following are three examples.

Key Canadian Consumer Bankruptcy Reforms

Today’s post is a summary of the key Canadian consumer bankruptcy reforms.  The most significant aspects of the consumer reforms touch on the following nine issues:

1.    Automatic Discharge
2.    Creditors’ Participation and Pay Out
3.    Bankrupts with High Income Tax Debt
4.    Bankrupts with Student Loans
5.    Treatment of RRSPs and RRIFs (tax sheltered retirement savings accounts)
6.    Tax Refunds
7.    Consumer Proposals
8.    Ipso Facto Clauses
9.    Trustee Fees

Below is more detail on each of these reforms.  I also have a short annotated book out on the reforms if you are interested in reading about them in more detail:

Stephanie Ben-Ishai, Bankruptcy Reforms 2008 (Toronto: Carswell, 2008): http://www.carswell.com/description.asp?DocID=5574

Introduction to the Canadian Bankruptcy Reforms

Thank you for the introduction Bob.  I am delighted to have the opportunity to Guest Blog this week about the Canadian bankruptcy reforms. 

On Friday September 18, 2009, the remaining amendments contained in Chapter 36 of the Statutes of Canada, 2007, and Chapter 47 of the Statutes of Canada, 2005 (c.36 and c.47) came into force:  http://www.gazette.gc.ca/rp-pr/p2/2009/2009-08-19/html/si-tr68-eng.html.  The coming into force of these amendments to the Bankruptcy and Insolvency Act (BIA) and the Companies' Creditors Arrangement Act (CCAA) brings to a close a long, frustrating, and confusing reform process.  While there are a number of promising components in the reforms, there is still much that could have been done.  Hopefully we (academics) won’t lose steam in pushing for future reforms and the regulators won’t feel that their work is done.  In today’s post, I’ll restrict my comments to background on the reforms and the process.  In the next post, I’ll briefly highlight the key consumer bankruptcy reforms.  For the last three posts I’ll offer a critical analysis of the consumer bankruptcy reforms.  Outside of the references to the commercial reforms in this post I will not focus on them this week, as time does not permit me to do a thorough job on both consumer and commercial reforms.  That being said there are significant commercial reforms that will have an impact on consumers, in particular the labour reforms.

Exporting Chapter 11

FT has a great, and extensive, article today about the push to adopt chapter 11-like procedures in Europe. One thing missing from the article is any discussion of the relative size of the respective jurisdictions. My sense is that chapter 11 works best for the very largest American firms, especially since the 2005 amendments to the Code made chapter 11 a very inhospitable place for small businesses. The U.S. has a sufficiently large number of big and mid-sized debtors to warrant a system like chapter 11, but I wonder if any individual European jurisdiction, even the U.K., can justify implementing a system that best serves a handful of debtors each year. What they really need is a chapter 11 process, with a dedicated court system, at the EU level, but I think we can agree that is unlikely.

Highly Questionable Medical Bankruptcy Figures from Fraser Institute

The National Center for Policy Analysis (NCPA) is flogging a study from the Fraser Institute in Canada that purports to show U.S. medical bankruptcies are a "myth" because the Canadian bankruptcy rate is higher than in the United States. Reuters and BusinessWire have run the NCPA's press release as a story on their news services. Before anyone takes this study seriously, a few important facts are needed to place the Fraser Institute findings in context. To be as charitable as possible, the study's use of the bankruptcy data is extremely selective.

First, the Fraser Institute study begins by observing that advocates of a single-payor U.S. health care system use the assumption that such a system would prevent many U.S. bankruptcies because of the medical debt found among many U.S. consumers filing for bankruptcy. The study states, "We should expect to observe a lower rate of bankruptcy in Canada compared to the United States, all else being equal." First, I'm not sure that is an assumption made by advocates of a single-payor system (and I don't count myself as one of them). Second, the qualifier "all else being equal" is the whole point. There is a lot that is not equal between the U.S. and Canada, and there is no reason to expect bankruptcy rates to be precisely similar. Even on its own terms, however, the Frasier Institute study is highly suspect because of the narrow window it uses for its bankruptcy data.

The Fraser Institute study, which is really just a three-page report of existing data from government sources, used bankruptcy filing data for the calendar years 2006 and 2007 as the "most recent data." Both the Office of the Superintendent of Bankruptcy Canada and the U.S. courts have 2008 data available. For a report that carries a July 2009 date, the years 2006 and 2007 would not seem to be the most recent data available. Authors have to prepare publications in advance of their appearance, but the U.S. data were available in a press release dated March 5, 2009, and the Canadian data appear on a web page that states "modified March 11, 2009." There was surely plenty of time to use the 2008 data for a 3-page paper that has fewer data than this blog post. By limiting the data to 2006 and 2007, however, the report is able to support that the anti-health care reform agenda that the NCPA and the Fraser Institute seem to further.

Transnational Bankruptcy

At the final day of the INSOL conference in Vancouver, I attended a fascinating panel on the issues that arise when a multinational corporate group seeks to reorganize. The panel was staffed by judges from Canada, the UK, Korea, and Germany -- and  deftly chaired by a U.S. judge who managed to resist drawing the discussion back to the U.S. For those of us from the U.S., I think the discourse was particularly enlightening. While the panel began with lots of optimism about the new tools for cross-border coordination, by the end it became plain that only Canada would consider a joint reorganization case. In the other jurisdictions, it was clear that the vision of a cross-border case was actually a series of parallel cases within the several jurisdictions, aimed at reaching a common point.

The distinction is important, and a point that is often lost in the good-feeling surrounding the adoption of chapter-15-like procedures. In a joint reorganization case, creditors are apt to be treated equally, based on the value of the unified enterprise. In the case of parallel proceedings, creditors in those jurisdictions that happen to have readily "realizable" assets are going to have significant holdup power, especially if the assets remain "local" as part of a separate bankruptcy proceeding. For local secured creditors, that may be a fair result, but for unsecured creditors who likely relied on the value of the overall enterprise, this sort of jurisdictional fragmentation is likely to produce very arbitrary (and likely inefficient) results.

GM & Opel

On the day GM filed, the Times ran a story noting that GM's European division – Opel/Vauxhall – had been “spared” going into bankruptcy by the deal with Magna and some Russian investors.

Are we so certain they were spared?  Sure in the short term European employees and others who rely on GM will avoid some pain, but what about the long term?  The domestic part of GM is talking about dropping over 2,000 dealers, rewriting its labor contracts, massively reducing its debt load and shuttering several plants, all in about a month.  Will Opel’s new owners be able to achieve a similar degree of restructuring in anything close to that timeframe?  It may be my American chauvinism, but my impression is that it will be even harder to obtain a comprehensive restructuring of Opel outside of a bankruptcy process, as the European jurisdictions have much stricter laws regarding the termination of employees, shuttering plants, etc.

As GM and its stakeholders are now learning, sometimes avoiding bankruptcy simply makes the pain worse when it comes.  GM's chapter 11 case would have been much simpler (relatively) two years ago, when the credit markets were open and people where still buying cars.

(I invite the European readers to comment or correct me in the comments or via email.)

Consumer Overindebtedness Around the World

My plan for the evening is to go in search of a giant sculpted head of Karl Marx. Fortunately, I'm in Chemnitz, Germany, where such a monument is a feature of the town square, a holdover from the days when the city was known as Karl-Marx-Stadt. Dr. Wolfram Backart has organized a wonderful conference at the Technische Universtät Chemnitz. The conference is entitled "Overindebtedness: Everyday Risk in Modern Societies? Theoretical Aspects and Empirical Findings in International Perspective" and has brought together scholars from Germany, China, Portugal, Japan, Sweden, South Africa, Finland, Canada, the United States, the United Kingdom, and Austria. Two themes have been emerging

Austrian Banks, East European Subprime, and Hungarian Consumer Bankruptcy

Change the names, and you don't even have to read the rest of the story any more. Europe and the United States are on parallel tracks to hell in a handbasket. Today's Washington Post has a fascinating story on the woes of Austrian bankers, whose drive to conquer emerging East European credit markets is now coming back to haunt them. Substitute Wells Fargo and Citigroup for Erste Bank and Raiffeisen Bank, and mention California, Nevada, and Florida instead of Hungary, Romania, and Ukraine, and any U.S. reader of popular news can see what's coming. Austrian banks for years ignored warning signs that these fast-growing markets were overheating, and the banks expanded faster than regulators could keep up--sound familiar? The big problem in Eastern Europe was banks would lend Euros or Swiss Francs to, say, Hungarians, at lower interest rates than similar loans denominated in local currency (e.g., Hungarian forints). While it's probably overkill to call these "subprime" loans (and the borrowers were generally creditworthy), these loans were subject to a different but still substantial risk; i.e., a potential upside-down position for borrowers if currency markets shifted, which is exactly what happened a few months ago. Imagine earning your pay in Russian rubles but having to repay in U.S. dollars, especially after the exchange rate of the former heads south.  Not good.

Party Time in the Netherlands?

A comment from the Netherlands reminded me to post about an intriguing statistic I've been exploring. While consumer insolvency filing rates have been up around the world this past year (at least in the last quarter of 2008, as mentioned here and here), the Netherlands represents a serious anomaly. Total admitted consumer cases there plummted 38% in 2008, including a 42% drop in Q4 2008 as compared to Q4 2007, and a 1% decline from Q3 to Q4 of 2008. This is seriously surprising and somewhat troubling.

On the one hand, it might be that Dutch debtors are just way better off than their neighbors, and consumer financial distress is low in that corner of Europe . . . but I doubt this very much. The Raad voor Rechtsbijstand, which follows developments on the Dutch consumer insolvency law (known by its acronym, WSNP) has also expressed confused anxiety about the source of this drop in admissions (see here and here, in Dutch, noting among other things a 67% drop in admitted cases in Haarlem and a 54% drop in Rotterdam in the first half of 2008). The Raad speculated that perhaps improvements in the out-of-court workout process had led to less need for formal, coercive relief, but my own quick review of the results of that system and remarks from a friend in the Netherlands suggest that a slight uptick in consensual out-of-court arrangements does't begin to explain a 38% drop in admitted formal cases.

Alternatively, it could be that a reform implemented on 1 January 2008 drove down the admission rate, though I doubt this tells the whole story, either. The reform generally made the system simpler and more predictable, which should have made it more attractive to filers. While it made small changes in the admissions criteria (article 288 of the WSNP), I can't imagine that any of these seemingly minor changes would explain the drop. My Dutch colleague suggested that courts might be much more restrictive now in admitting cases for debtors whose problems are viewed as predominantly "social" rather than "financial" (e.g., drug addiction, compulsive disorders, inability to control spending [sic!]), so these needy cases may not be making their way into the system after 1/1/2008. I don't see anything in the paper record to support this view, but I'm still looking, as this disturbing approach to consumer relief would signal a very significant shift in perspective. As anyone who has dealt with consumer cases knows, MOST consumer insolvency clients have some substantial problem that might be categorized as "social" rather than "financial," and there's a strong causal connection between the two . . . but that certainly doesn't mean that these folks don't need (or wouldn't benefit greatly from) debt relief.

Hoping for Failure!?

As if negotiating a confirmable reorganization plan weren't difficult enough already, apparently credit default swaps (CDS) are making it even more difficult. The March 7th issue of the Economist has a great sidebar article, aptly entitled "Burning down the house." The author helpfully analogizes CDS to fire insurance--if a corporate borrower defaults (i.e., the house burns down), the CDS seller pays the buyer for the loss. That seems like an acceptable hedge if the buyer of a CDS is the lender, but what if high-risk investors (speculators?) buy CDS, banking on a corporation's default (akin to "naked short selling" of a company's stock, a tactic also under attack of late).

This explosive situation comes to a head if the borrower company attempts a reorganization. Now you've got very dedicated and often aggressive investors hoping for your failure! If they have enough riding on the CDS paying out, one can easily imagine a CDS holder offering to buy a blocking position (34%) of the unsecured debt of a company attempting reorganization--which the CDS holder can probably do for a song in light of the pending reorganization (and the payout on the CDS will almost inevitably be more than a plan promises to unsecureds). I've heard lots of grousing among judges wanting to know how certain "creditors" voting unsecured claims came to own those claims--now I understand why these judges want that info and what scary info they might find if the question is answered. I presume the "not in good faith" votes of CDS holders voting down a reasonable reorg plan could be equitably subordinated or classified (rejected). What a nightmare for debtor's counsel! All that work to then have your plan fail because investors with no real skin in your game tank your deal so they can collect the equivalent of hazard insurance on your failure. 

It gets worse when national borders are involved. The Economist article mentions the Chapter 11 case of LyondellBasell, initiated in early January. Apparently, some CDS holders want to force the debtor's European parent to default, bringing in the complications of a cross-border reorganization. That would so complicate the case that the chance of a total meltdown--and a payout on the CDS--would spike, so DIP lenders have ponied up just to avoid that eventuality. The strategies of securing plan support are FAR more complex today in the CDS-influenced and cross-border complicated world of reorganization. I guess that's why the bankruptcy lawyers get the big bucks.

We're in the Money!(?)

Here in the U.S., lawyers in other areas must be eyeing their bankruptcy counterparts with envy, as our sector enjoys (if we can use that word without multi-directional guilt!) rapid growth while others areas are contracting. In England, this U.S.-bankruptcy-lawyer envy is doubly powerful, as even bankruptcy lawyers there are not as high-profile as in the U.S. As this TimesOnline story reminds us, reorganization ("administration") in the U.K. is not a lawyer-driven process, as is the Chapter 11 process in the U.S. Rather, it is an administrative process run mainly by accountants, who exercise significant business discretion with much less court oversight, and therefore much less need for lawyers. As more global businesses run into trouble, insolvency professionals from these two great nations separated by a common language will come into contact more frequently. When this happens, we U.S. lawyers need to remember that our U.K. colleagues are situated quite differently, and the reorganization process there is administered in a very different way. Just ask Richard Gitlin, who could regale us endlessly with stories about liaising (perhaps "doing battle" would be more apt?) with PriceWaterhouse in the Maxwell bankruptcy in the early 1990s (CreditSlips blogger John Pottow, among many, many others, has written about the case here). When these cross-cultural encounters among lawyers occur, let us U.S. bankruptcy lawyers try not to be too smug (for the humor impaired, yes, this is a little joke!).

Rising Pain in the Heart of Europe

Apparently, statistical agencies all over the world are finally releasing their 2008 bankruptcy data. The AOUSC released its CY 2008 report yesterday, and today, the German agency (DeStatis) released the report for December and CY 2008. As it usually does, DeStatis tried to paint a rosey picture--the headline is "7.1% fewer consumer bankruptcies in CY 2008." This seems to contrast quite nicely with the 31% rise in U.S. bankruptcy filings. But the DeStatis report reveals that business filings rose 13% from a year earlier, and non-business filings rose 12.3% in December 2008 over December 2007, nearly 13% for "pure" consumers (as opposed to former small-business people). The Q4 filings, especially December, show a rapid and troubling spike, and one suspects this will continue in force well into 2009. Hang on!

Consumer Insolvency Filing Pattern Variations

The latest figures for insolvency filings in Sweden are now out.  Somewhat contrary to Bob's observations on U.S. filing patterns in the last quarter of the year, Sweden saw a 21.5% increase in filings in Q4 2008 over Q3 (and a 21.7% increase in filings in Q4 2008 over Q4 2007). Total filings for 2008 were slightly down from 2007 (6528 in 2008, 6831 in 2007, in a country with about 9 million total residents), but 2007 was Sweden's equivalent (actually, opposite) of 2005 in the U.S.--a huge rush of filings occurred in Q1 2007 after the implementation of a reform to make the system simpler and more widely accessible.  The biggest difference between 2007 and 2008 was thus the rate at which the administrative structure made its way through the huge backlog of new cases. The number of orders opening insolvency proceedings rose steadily through 2007 and 2008 and then spiked over 63% from Q3 to Q4 of last year in what appears to have been a major push to clear out old filings. Luckily for Swedish debtors, while the successful admission rate has returned to its historical level of about 55% of filings, the filing rate per 1000 residents has spiked to around 0.75 since the 2007 reform, so nearly 70% more debtors are being successfully admitted to the system now in comparison to two years ago. Unfortunately, very little empirical data exists on the content of the relief granted to these people, but the 2007 amendents have made some form of relief much more widely available and substantially more predictable. This is a trend that has swept over Europe in recent years, quite the opposite of what we've seen here in the U.S. It's tought to make accurate and meaningful comparisons between Europe and the U.S. in these complex systems, but the contrast in direction of reform policy is striking.

The Father of Consumer Bankruptcy in Continental Europe?

I hope some kind CreditSlips reader can confirm (or at least not disprove) what I believe to be my recent exciting discovery. For nearly a decade, I've searched for the stone that caused the very first ripple that became the wave of consumer bankruptcy (i.e., discharge) laws across continental Europe in the 1980s and 1990s, and I think I've found it. Thanks to extraordinary help from Ulrik Rammeskow Bang-Pedersen at the University of Copenhagen, I've identified what I believe to be the first published suggestion that a continental European nation should adopt a specific regime of coercive debt reduction (discharge) for consumers. The comment appeared in a Danish law journal in January 1972, and it was written by a barrister named Frederik Bang Olsen (father of Peter Bang-Olsen, a current lawyer at what formerly was the Bang-Olsen firm, now Ret&RådAdvokater--thanks, Peter, for the background info!). One can clearly trace the development from this comment into a private law reform initiative and report that led to the adoption of the Danish debt adjustment act in May 1984 (the first consumer insolvency law in continental Europe--influenced, but not very powerfully, by the earlier laws in England and the United States).

I have found discussions of debt relief and discharge in other European countries beginning in the 1980s and later, but never anything as early as 1972. France adopted the second consumer debt relief law on the continent on December 31, 1989, but it contained no general discharge provision (yet), and I have not found any evidence that discussions of that law began before the early 1980s. This would explain my fascination (obsession?) with European consumer bankruptcy, as both it and I were born in 1972.

So, three cheers for the father of European consumer bankruptcy, Frederik Bang Olsen! What an amazing story of grass-roots initiative that finally moved past a centuries-old rule (pacta sunt servanda) and changed the world for the better for countless others to follow. Inspiring!